Private equity groups going after foreclosures as rentals market
Waypoint founders Colin Wiel and Doug Brien set out to show that by using technology they could amass single-family homes the same way Sam Zells' Equity Group Investments gathers apartment units.
Ken Major climbs the steps of a county courthouse in a San Francisco suburb with $500,000 in cashiers checks in one hand and a list of addresses in the other. Major is a buyer for Waypoint Real Estate Group, an Oakland-based investment firm that's scooping up foreclosed homes in California.
On this December afternoon, he joins a dozen house flippers as an auctioneer starts hawking the latest batch of defaulted properties to hit the market. Major bids on a three-bedroom house in Antioch, and after other buyers counter, he wins at $147,600.
"We got it," he mutters into a mobile-phone mike dangling from his ear. The house was valued at more than $400,000 in 2006.
Waypoint, a private-equity real-estate fund with $150 million in assets, is pioneering a new approach to making money from the housing crash. Since 2007, investors have been trolling the cratered suburbs stretching from California to Florida for cheap houses to flip. And firms such as PennyMac Mortgage Investment Trust have sought value in subprime-mortgage-backed securities.
Waypoint, which owns 1,100 houses and is buying five more a day, is betting that converting foreclosures into rentals is a better way to make a profit. Other firms, such as Landsmith in San Francisco, are cropping up and pursuing the same strategy in Arizona, California and Nevada.
With many suburban homes selling for half their peak values and demand for rentals from prospective tenants climbing, Waypoint was earning an 8 to 9 percent return on its capital as of Dec. 31, according to a quarterly report it sends to clients. The cost of renting in the U.S. reached an all-time high compared with that of buying a home at the end of last year, indicating it's a good time for investors to purchase, Deutsche Bank analysts said in a note in March.
Should property values rebound, Waypoint may earn at least 20 percent from appreciation in an eventual sale of the houses, says Colin Wiel, who co-founded the firm in 2008 after backing technology startups as an angel investor.
"I never thought I'd be rolling up single-family homes," Wiel says. "But the yields are awesome."
New breed of investors
Wiel and Waypoint co-founder Doug Brien make an unlikely pair of real-estate entrepreneurs. Wiel, 45, is a mechanical engineer who designed braking systems for jetliners at Boeing in the 1990s.
And Brien, 41, is a former kicker who won a Super Bowl with the San Francisco 49ers in 1995 before earning a postgraduate degree in business at Tulane University in New Orleans.
In starting Waypoint, Wiel and Brien set out to show institutional investors that by using technology they could amass single-family homes the same way Sam Zells' Equity Group Investments and other real-estate giants gather apartment units in cities from New York to San Francisco.
The home-rental market boasts a total property value of $3 trillion, according to Morgan Stanley housing analyst Oliver Chang. Yet institutions have long shunned it as too scattered and impractical to be profitable.
Wiel and Brien are using cloud computing, proprietary algorithms and iPads to create a virtual assembly line for buying, renovating and renting houses on a large scale. They're also betting that many former homeowners who have jobs but couldn't afford their mortgages will still want to live in the same communities as renters.
Last year, Columbia University's $8 billion endowment invested $25 million with Waypoint. In January, GI Partners, a Menlo Park, Calif.-based private-equity firm that manages money for the California Public Employees' Retirement System and other pension plans, agreed to invest up to $400 million with Waypoint and acquire a minority stake in the firm.
The same month, Oaktree Capital Management, the Los Angeles investment firm co-founded by billionaire Howard Marks, announced a $450 million deal with Santa Ana, Calif.-based Carrington Capital Management to acquire and convert foreclosed single-family homes into rental properties. Carrington already rents out more than 3,000 houses in California and other states.
Early days for model
Until last year, single-family-home rentals was a mom and pop market, says Stephen Duffy, an investment banker at Moss Adams Capital, an Irvine, Calif.-based firm that finances real-estate investments. Now, it has grabbed the attention of institutional private equity because foreclosures haven't cleared and these properties can generate high yields for years.
Waypoint's researchers must plumb school-desirability ratings, crime statistics and other hyperlocal data to ascertain the income value of each house. Its title agents must often disentangle foreclosures from second mortgages and liens. And leasing representatives have to find qualified renters in communities struggling with high unemployment rates.
"This is a nascent market, and the model still hasn't proved out," says Rick Magnuson, executive managing director of GI Partners, which has $6 billion under management. "But we believe this rental strategy will produce good economic returns for our investors and help arrest the housing markets slide."
Even though mortgage rates are hovering at a historic low of 3.8 percent, consumers bought only 324,000 new homes last year, the poorest annual performance since 1963.
On Feb. 9, the Department of Justice and 49 states agreed to end an inquiry into abusive mortgage practices at Bank of America, JPMorgan Chase and three other banks after striking a $25 billion settlement with the companies. Even so, the settlement may not be large enough to reboot a housing market saddled with $700 billion in underwater mortgages. Ivy Zelman, CEO of Zelman & Associates, a Cleveland-based research firm, says institutional investors eyeing the rental market have the capital to absorb thousands of dwellings and slow the markets decline.
Investors are already having an effect: The supplies of homes for sale in Phoenix, Orlando, Fla., and other hard-hit markets have fallen more than 60 percent from their post-crash highs as bargain hunters scoop up foreclosures.
Investors are aggressive about buying these homes in front of the government program, Zelman says.
In August, the Federal Housing Finance Agency (FHFA) asked investors for input on setting up a foreclosure-to-rental program to offload some of the 180,000 repossessed homes held by Fannie Mae and Freddie Mac, the troubled government-sponsored mortgage giants.
Barclays Capital, Deutsche Bank, Fortress Investment Group and Waypoint were among the hundreds of firms that submitted proposals to the FHFA spelling out how investors could participate in such an initiative, according to information obtained by Bloomberg News through a Freedom of Information Act request.
On Feb. 27, the FHFA unveiled a pilot program to sell repossessed houses in Los Angeles, Phoenix, Florida and other hard-hit markets to investors who qualify with the agency. Waypoint submitted an application. This could be a total game changer for us, Wiel says.
"It's striking that Washington is looking to Wall Street for answers after investors' zeal for subprime mortgages helped foment the housing morass," says Ginna Green, a spokeswoman for the Center for Responsible Lending, a Durham, N.C.-based consumer advocacy organization.
Still, she says, leasing defaulted houses does reduce the corrosive impact they have on communities. "Nobody wins when houses are empty," Green says.
Wiel and Brien, both graduates of the University of California, Berkeley, met at an angel investing conference Wiel was hosting in San Francisco in 2008. They talked about the housing crash and agreed that plunging property values in the Bay Areas bedroom communities presented an irresistible opportunity.
So they set up a company with $1 million of their own money and acquired 26 houses during the next six months.
From the outset, the duo applied technology to a business rooted in the shoe-leather world of appraisals, home inspections and foreclosure sales on courthouse steps.
"We asked how do we systematize and automate everything? How do we scale?" says Wiel, an upbeat man who's fond of techie lingo.
By 2011, they had hired almost 100 employees and raised more than $90 million from investors in seven funds. Waypoint uses a combination of its own proprietary algorithms and business software from San Francisco-based Sales'force.com to turn potential acquisitions into rentals. This proprietary program ranks potential acquisitions by factoring in location, proximity to freeways and commuter trains and the homes historical property-value performance. Doug Pankey, a longtime appraiser, watches as the program calculates that with a maximum bid of $150,293, Waypoint can rent the residence for $1,799 a month and earn a 7.7 percent annual return.
For all of the cloud computing, the business of converting foreclosures into rentals is often about dealing with households under enormous fiscal stress. Waypoint employs former financial counselors from nonprofit organizations to help tenants repair their credit and even set up household budgets so they don't fall behind in their rent.
As Waypoint triples the number of houses it buys daily and expands in California and possibly Nevada, Arizona and Illinois, it will have to hire dozens of appraisers, leasing agents and other personnel.
While Waypoint's strategy is drawing interest from Wall Street and Washington, D.C., Wiel and Brien still must bring order to the inefficient business of turning around foreclosures. And they'll have to show investors that the endeavor is worth the trouble.
Information in this article, originally published April 14, 2012, was corrected April 16, 2012. A previous version of this story was missing the first name and title of Ginna Green, a spokeswoman for the Center for Responsible Lending, a Durham, N.C.-based consumer advocacy organization.